ECON 201
Lec 10.1 b
6-09-2009
Environmental Economics
Negative Externalities
&
Optimal Regulation
Wrapping Up:
Incentive Regulation
• Sappington & Weisman
– Implementation of rules that encourage a regulated
firm to achieve desired goals by granting some, but
not complete, discretion to the firm
• Three features of incentive design
– Regulatory goals must be clearly specified before
design
– Regulated firm is granted some discretion
– Regulated firm is not granted complete discretion
Why Not Complete Discretion?
• Why some discretion:
– Firm has better information than the regulator
about key aspects of the regulated industry
•
e.g., costs structure/production technology,
customer preferences/demand
• Why not complete discretion
– Firm may have different goals than its
customers/society
• Recent examples in Banking & Finance (AIG)
Environmental Economics
• What is it?
– Application of economic analysis to
environmental and natural resource issues
• Environmental
– Air and Water Pollution (negative externality)
• Natural Resources: optimal management
– Fisheries (common property)
– Forestry (renewable)
– Mining and oil production (non-renewable)
Why Are These Markets Different?
• Externality
– Production/consumption of a good imposes a
cost (negative) or benefit (positive) on others
not involved in the market transaction
Externality
• Many negative externalities are related to the
environmental consequences of production and
use
– Air pollution
• Greenhouse gases related to burning of gas, coal, oil used in
heating, production and transportation
– Water supplies
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•
•
•
Run-off from drainage systems (Downtown)
Fertilizer run-off (Eastern Washington)
Dumping of waste by-products (Duwamish)
Nuclear contamination (Hanford)
What’s the Problem?
• Divergence between private and social marginal costs
What Are the Consequences?
• Without Intervention
– Consumers/producers will not take such costs into
economic decisions
• Produce too much of the good & externality (e.g.,
pollution)
What Are the Remedies?
• General types of solutions:
– Criminalization: making it illegal to dump
pollutants into the air/water/landfills.
– Civil Tort law: For example, class action by
smokers, various product liability suits.
– Pigovian taxes or subsidies intended to
redress economic injustices or imbalances.
– Establishing/assigning property rights
(Coase’s theorem)
Negative Externalities
Pollution
• A Pigovian tax is a tax levied to correct the
negative externalities of a market activity.
– may be levied on producers who pollute to encourage
them to reduce pollution,
– Also provides revenue to counteract the negative
effects of the pollution
– Certain types of Pigovian taxes are sometimes
referred to as sin taxes, for example taxes on alcohol
and cigarettes.
• Pigovian taxes are named after economist Arthur
Pigou (1877-1959) who also developed the
concept of economic externalities.
Pigovian Taxes
Market-based Solutions
vs. Regulation
• Argument against the levying of Pigovian pollution taxes
is that if the tax is too high it will lead to a level of
pollution that is less than the social optimum.
• The alternative, regulation, is viewed as having a higher
cost to society because Pigovian taxes raise revenue
and respond automatically to changes in the market
such as lowered cost of production or pollution
mitigation.
• With a Pigovian tax there is always an incentive to
reduce pollution, whereas with direct regulation, a
polluting company has no incentive to pollute any less
than what is allowable.
Negative Externalities and
Property Rights Solutions
• an alternative to Pigovian taxation
– markets for "pollution rights"
– not generally more efficient than Pigovian taxes but are often more
appealing to policy makers because giving out the rights for free (or at
less than market price) allows polluters to lose less profits or even gain
profits (by selling their rights) relative to the unaltered market case.
– Markets for emissions trading have been set up to bring better
allocative efficiency and improved information sharing to the pollution
externality problem. Pollution rights markets are a part of the field of
Environmental Economics generally, and Free-market environmentalism
specifically.
• Perhaps the biggest problem with the Pigovian tax is the "knowledge
problem"
– "It must be confessed, however, that we seldom know enough to decide
in what fields and to what extent the State, on account of [the gaps
between private and public costs] could interfere with individual choice."
Coase’s Theorem
• If property rights exist and transaction
(bargaining) and information costs are low
– Then parties will be able to bargain among
themselves (without government intervention)
to obtain an efficient outcome
Establishing Property Rights
• Fishing Industry
– ITQs: Individual Transferable Quotas
• Boats bid on the right to catch pre-determined amount of fish
– Can either catch or sell license
• Cap and trade systems for pollution/air quality
(Emission trading systems)
– California
– International
• Taxis
– Taxi shields
Environmental Economics
Externalities
• Externalities
– When there is a divergence between either:
• Social/Private Marginal Benefits, or
• Social/Private Marginal Costs
– Common property
• Commonly held property: e.g., fishing grounds,
common agricultural land
• Pure Public Goods
– Is this a useful distinction? (Positive
Externality)